Climate change issues needs to be incorporated in financial reporting

Tuesday 7 July 2020

Climate change and financial reporting

Author: David Pitt-Watson

David Pitt-Watson, Visiting Fellow at Cambridge Judge Business School, writes about why companies must examine the effects of climate change when working out their accounts

Climate change is a big issue – many would say, the biggest of all issues. So investors are hungry for hard information on the impacts it will have on companies, and how it will affect investment opportunities.

But although there are a number of excellent initiatives for climate disclosure in the ‘front end’ of the annual report, accounting standards seemingly allowed companies to ignore the effect of climate in drawing up their accounts, and calculating their profits.

Until now, that is.

At the end of last year accounting standard-setter the IASB (International Accounting Standards Board) published a paper on the accounting treatment of climate issues. This paper explained that companies reporting under IFRS (International Financial Reporting Standards, i.e. companies from the bulk of the world outside the US) need to incorporate material climate change issues into their financial reporting.

The effect is potentially dramatic. Readers may have noted that BP recently announced a change in its oil price assumptions that may lead to a write-off of up to $17.5 billion, and is reappraising its future capital spend. The company’s auditor – following the IASB advice – had noted that the previous price it had used was incompatible with the Paris Accord.

The IASB paper is comprehensive. It notes that climate change needs to be considered when companies are assessing a number of crucial accounting calculations, including: asset valuations and impairments; useful lives of assets; provisions and liabilities arising from fines or penalties; and credit losses for loans. Management should also disclose the climate-relevant assumptions that they make in creating their accounts – such as asset lives or the future price of oil – along with the sensitivities of their reported numbers to changes in those assumptions so that investors can test how different climate-related forecasts might affect the financials.

This is critical information in allowing an assessment of how sustainable a company’s operations will be. As investors, we need this change to be delivered not just by one sector but across the investment universe. This will happen, but only if investors demand it happens, and companies and their auditors are aware of the importance of the IASB paper.

The role of investors is central to this process. Materiality in IFRS is based on the views and wishes of investors, so investment institutions need to emphasize to their investee companies that they believe climate change is material and that they expect financial reporting to reflect this.

That is where CFA members might fit it. Can we get the message out to companies and their auditors? If we can, we should not only get a whole load more relevant information, we will also take an important step in helping address climate change – perhaps the most critical issue the world currently faces.

The IASB paper will be discussed at a CFA UK Webinar: Accounting for climate. Getting the numbers investors need on Tuesday 28 July at 17:00.

 

David Pitt-Watson, Visiting Fellow at Cambridge Judge Business School David Pitt-Watson, FSIP, is a Visiting Fellow at Cambridge Judge Business School, and has been active in various initiatives to promote responsible investment

 

 

 

 

 

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